Doing 9-9-9-style tax reform right

The 9-9-9 plan is a mess. It’s poorly constructed and comically regressive (have you seen this graph?). But to be fair to Herman Cain, it’s based on some genuine insights about the American tax system. The tax code should be simpler. And it should include a consumption tax. It’s just that it should also be progressive and, you know, work. But luckily, there are plans out there that do all of these things.

(Jim Cole/AP)

In 2005, one of the options that President George W. Bush’s tax reform panel proposed (pdf) was called the “Growth and Investment Tax Plan” and it closely resembled the X tax. You can get pretty much any level of progressivity you want by fiddling with the rates and deductions, and adding refundable credits, but the basic structure is designed to give you the best of a consumption-based system with the best of a progressive-income tax system.

A straight consumption tax that gets a lot of press is the FairTax, but for reasons Bruce Bartlett has laid out here (pdf), the FairTax is extremely regressive, and for separate reason, vulnerable to enormous amounts of tax evasion.

Cornell economist Robert Frank has argued for a consumption tax that is both simpler than the X-tax and more progressive and easier to enforce than the FairTax. “People would report their income to the Internal Revenue Service as they do now and also their annual savings, much as they currently document contributions to 401(k) and other retirement accounts,” Frank explained in the American Prospect. “The difference between these two amounts, less a large standard deduction — say, $30,000 for a family of four — would be the family’s taxable consumption. Rates would start low, perhaps only at 10 percent. In this illustration ... as taxable consumption rises, the tax rate on additional consumption would also rise.”

He goes on to note that the progressivity carries another benefit, too: It discourages excessive spending. “With a progressive income tax, marginal tax rates cannot rise too far without threatening incentives to save and invest. Under a progressive consumption tax, however, higher marginal tax rates actually strengthen those incentives.”

Let’s unpack that for a moment. The problem with moving to a straight consumption tax is that you need very high rates in order to retain progressivity. Some tax experts see that as a problem, as high marginal tax rates change people’s behavior. Frank sees that as a good thing.

One of the points of his tax is that when people are spending a lot of money, they tend to be spending it not on things they need or enjoy, but on useless and socially destructive status competitions with one another. “Hedge-fund managers need a 40,000-square-foot house and Gulfstream jet only because their peers have them,” wrote Frank. “Evidence suggests that if top earners all spent less on such things, their lives would be no less fulfilling than before.” And those expenditures trickle down the income scale, forcing everyone to spend more to keep up with their neighbors. The result is that everyone ends up slightly worse off, spending more for things they don’t really want. That’s wasteful, Frank thinks, and a progressive consumption tax could discourage it and move that money toward more productive investments.

But if you don’t want such onerous rates for high earners, you can add progressivity in on the spending side. “I wouldn’t go all the way to a consumption tax because I don’t think you can get an adequate level of progressivity,” says Len Burman, a tax expert at Syracuse University, “but it might change my mind if there was a rock-solid commitment to a robust social safety net. In Europe, you have regressive value-added taxes paying for universal health care, and that’s a good trade.”

“The other issue,” says Bob Williams of the Tax Policy Center, “is the transition question. How do you get from here to there? Moving to a consumption tax is really hard on people who have saved. Now they have to pay taxes when they spend that money.”

But if you could answer that question, this would be an unusually good time to move to a consumption tax. Right now, we’re in an unusual moment where we actually want people to spend more money in order to get demand back up across the economy. If people and businesses knew a consumption tax was coming, they would have a reason to spend now, before it hit, rather than socking away their money. That could mean a very big stimulus in the short term.

So is Cain’s plan a good idea? No. Not at all. But there are at least a couple of good ideas behind Cain’s plan. Now some presidential candidate or eager legislator just needs to wrap them into a good policy.

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